THE IMPACT OF TAXES ON THE DIVIDEND POLICIES OF BANKS IN NIGERIA

PROJECT INFORMATION

Format: Ms Word /  Chapters: 1-5 /  Pages: 110 /  Attributes: Data Analysis

ABSTRACT

This study attempts to explore the impact of taxes on the dividend policy of Nigerian banks. T o do this, it tries to answer questions as to the actual relationship between taxation and dividend pay-out ratio. It also attempts to explore the possible impact of profits on the dividend pay-out and examines factors influencing dividend policies. The purpose is to reveal how propounded dividend policy theories could apply to Nigerian banks and to make relevant recommendations. The study covers all banks quoted on the NSE using a sample size of 10 banks systematically selected and sample period of 10 years, judgmentally selected. A causal research model is adopted and secondary data sources (NSE Fact Books and Audited Accounts) are employed to collect relevant data. The study first computed the averages of the variables from the sample banks so that a common value is obtained for each of them, after which the pooled data is used to run a time series analysis based on the Ordinary Least Squares regression method. The study finds, amongst other things, that a 1% increase in taxation will cause a 32.47% decrease in DPR while a 1% increase in EPS will cause a 28.49% increase in DPR. However, there is no significant impact in any of the exogenous variables on the endogenous variable. The results suggest some form of induced dividend policies going by some of the effects of the banking recapitalisation program of 2004/2005 and other factors which include informational contents of dividends, high level of liquidity occasioned by the recapitalisation, need to sustain investor’s confidence and win over more shareholders’ funds, low investor protection in Nigeria, etc. The study recommends, amongst other things, that dividend policy adoption by Nigerian banks should be based on the particular circumstances of the banks and not necessarily on the traditional factors often formulated by academics. Also, a more detailed study may be necessary to clearly distil out the impact of the recapitalisation program on the dividend policy of banks in Nigeria

CHAPTER ONE INTRODUCTION 1.1     OVERVIEW This study attempts to explore the impact of taxes on the dividend policy of banks in the Nigerian financial system. Dividend policy is the exchange between retaining earnings and paying out cash or issuing new shares to shareholders; it varies from one corporate organization to the other depending on various factors. One of such factors that have been identified is taxation- taxes the corporate organization must pay over to government from their profitability either directly (as tax on the corporation itself — corporate tax) or indirectly (as withholding tax on dividends paid out to shareholders).

Corporate tax is paid directly on profit made, whether or not the company pays dividends to its shareholders and, in Nigeria, it is at the rate of 30% on taxable profits. Another such tax paid by the corporation in Nigeria, on profit made, is Education tax, which is 2% of taxable profits. Since such taxes are paid before profit available for possible dividend payment is known they reduce the amount of profit available for dividend payment.

The indirect (withholding or dividend tax) is that levied by government on the proportion of profit paid out to shareholders as dividends; it is levied at the rate of 10% of the amount so paid out. This is normally in addition to the taxes on profit and is therefore sometimes referred to as a phenomenon of “double taxation”; intending to mean that company owners have paid tax twice on their earnings from the business - first, through tax on profit made and secondly, through dividend tax. Consequently, it becomes obvious that taxes are important to investors and may impact on the dividend policy to be adopted. This study attempts to study the level of such impact.

Debates have been carried out by scholars on the impact of taxes on dividends and corporate financial policies for decades and many of these debates have generated a lot of controversies regarding the actual relationship between taxes and dividend policies. This, in turn, has attracted much of academic interests, consequent upon the need to settle the related controversies. The debate over the importance of dividend policy was first started by Miller and Modigliani (1961), who suggested that both firm financing and dividend policy were irrelevant for firm investment decisions and independent of the value of the firm. Financial theorists such as Brennan(1970), Masulis and Trueman (1988) have stipulated that taxes affect organizational corporate dividend policy. If this theory were true, then changes in dividend payout of the company would be anticipated every time the government changes its income tax policy. However, this does not always happen, especially in the banking business. Lintner (1956) asserted that the major determinants of dividend policy are the anticipated level of future earnings and the pattern of past dividends. This discrepancy may have underpinned M & M (1961) theory, which consequently provided a platform for the enormous debates and researches on dividend policy. It is worthy to mention that attention has been seriously focused on tax in these debates.

Tax is a compulsory levy imposed by government on the incomes of individuals and corporate organizations for the performance of its duties of social welfare. It is a levy imposed by the government against the income, profit or wealth of the individual, partnership and corporate organization (Ochiogu, 2001). Every corporate organization is therefore expected to pay taxes as one of its responsibilities to the society. Dividend policy, on the other hand, forms a major financial decision often faced by management of corporate organizations in their pursuit of maximizing the value of their organization. It allocates the company’s earnings between payment to shareholders and reinvestment in the firm. Dividends are usually paid to owners or shareholders of a business at specific periods and it depends largely on the declared earnings of the firm and the recommendations of the directors. Therefore, if no profit is made dividends will not be declared. But when profits are made the company is obligated to pay corporate tax and other statutory taxes to the government; the taxes reduce profit available for distribution/allocation by the organization. For several years, many postulations and assumptions have been made regarding whether such taxes paid by organizations actually affect a firm’s pattern of dividend policy, as already pointed out earlier. Although dividends affect the shareholders’ tax liability, it does not in general alter the taxes that must be paid regardless of whether or not the company distributes or retains its profit (Brealey, Myers and Marcus, 1999). Conscious of these postulations and assumptions surrounding dividend policy and all the associated controversies, this study is directed at evaluating the impact of taxes on the dividend policy of banks in Nigeria. The banking sector is of interest in this research because of the structure of its dividends. A couple of similar studies have been carried out in Nigeria but with approach different from what will be adopted in this study.

1.2     STATEMENT OF THE PROBLEM Problems are inevitable in achieving an end. The problem of whether or not there is a fundamental impact of taxes on dividend policy drives this research study. This is of considerable importance not only to management of financial institutions but also to investors planning portfolio, trying to develop a flow of investments. Again, there is the problem associated with the fact that empirical studies on the effect of taxes on dividend policy of banks have not reached a definite conclusion. Academicians have postulated several theories on what an ideal dividend policy should be but there seem to be a chasm with what is really obtainable in practice. There are extraneous factors dictating the tune of any policy to be applied by organizations. Financial theorists such as Wu (1996), etc., opined that evasion of taxes by a company is a key factor in the determination of the extent of which its dividend policy is affected. Miller and Scholes (1982) however admitted that taxes weigh tremendous influence on corporate dividend structure. Whether these are true has remained a matter of intense debate. The dividend irrelevant theory of M & M (1961) which assumes a perfect market is still very much held in contention but its principles underline most companies’ policies.

Three contemporary schools of thought have emerged with theories, all attempting to explain the dividend structure vis-à-vis the impact of taxation. These include the dividend irrelevant theory, bird-in-hand theory and the tax preference theory; they will be visited in details later. The many varied opinions regarding dividend policy and taxes are not only examinable but mind probing for academic research. This research is therefore stimulated by the lack of clear cut empirical analysis and findings on the effects of taxes on corporate dividend policies, with specific application to the banking sector in Nigeria.

The research will therefore attempt to ask the question “What impact does taxation have on corporate dividend policy as represented by the dividend pay-out ratio?” “What is the relationship between taxation and dividend pay-out ratio?” “Is there a significant relationship between taxation and dividend pay-out ratio?” “If there is a significant relationship between taxation and dividend pay-out ratio, in which direction is this relationship - are they positively related or negatively related?” As a subsidiary to the above, this study will also attempt to explore the possible impact of profits on the dividend payout ratio and also answer questions relating to factors that affect dividend policies of banks in Nigeria.

1.3     PURPOSE OF THE STUDY Most literature and empirical works on dividend policy are largely based on foreign models, which may not be applicable in the Nigerian context. Obviously, Nigerian banks operate in an environment that is rarely the same with that of their foreign counterparts. Thus, the purpose of this study is to reveal how propounded dividend policy theories could apply to Nigerian banks and the impact of taxes on dividend policy in the banks. The study will attempt to corroborate or disprove earlier similar studies conducted in Nigeria, adopting a different approach. Other purposes for this study are: 1.       To investigate the factors that affect dividend policies of companies, especially banks in Nigeria. 2.       To find out the influence of profit/earnings on dividend policy of banks in Nigeria. 3.       To make recommendations on ways of achieving effective dividend policy.

1.4     RESEARCH QUESTIONS The following research questions are drawn up to guide the study:

  1. Do taxes have any impact on dividend pay-out of banks?
  2. Will a change in tax policy lead to a change in dividend pay-out of firms?
  3. Does size of profit/earnings impact on dividend pay-out of banks?
  4. What factors affect dividend policies of banks in Nigeria?

1.5     RESEARCH HYPOTHESIS